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Three Ways to Prepare for a Stock Market Crash

Three Ways to Prepare for a Stock Market Crash

August 07, 2018

While the sky might not be falling, the stock market may be crashing---soon. Or, it may be 10 years from now. I can’t say for sure. However I was able to learn some things from the crash of 2008, and I would like to share them with you so that we can both learn from them.

Originally, I wanted to write this article to justify why I believe the stock market may have topped. But I believe that the links I posted in the last article (Bear Market on the Horizon: How Does a Financial Advisor Prepare) already speak for my thoughts in this regard. This week I did read another article in the Motley Fool that adds credence to my view. It’s about a metric that Warren Buffet uses (along with many others) that help him make investment decisions. It’s aptly called “The Warren Buffet Metric.” Suffice it to say that the tide of thought is slowly changing, and I’m not the only one feeling somewhat bearish.

Three Ways You Can Prepare for a Stock Market Crash

  • Examine your current portfolio (I will show you how)
  • Research individual bond asset classes and their performance in the past (2002,2008 downturns in particular)
  • Explore what seasoned investors are doing right now

The process I will walk you through will be straightforward without a lot of investment speak like beta, standard deviation, and a bunch of other terms that you don’t have to master to build a stronger boat.

Step 1. Examine Your Portfolio

When is the last time you looked at your 401K statement? I mean really looked. For step number one, you need to print out your holdings within your investments. Literally print them out. I know a lot of you GEN X and GEN Y may not even own a printer, so you might have to get creative. But I’d like to remind you that this is your hard-earned money. Hard. Earned. Money. You should make this examination tangible for a thousand reasons.

Once you begin studying your account(s) look for the following things:

  • Determine the percentage of stocks to bonds in your portfolio
  • Determine which of your holdings are NOT stocks (equities)
  • Of the bond holdings that you should now easily be able to define, write down their names and the amounts you have in each (these could be your strongest bastion if history repeats itself)

You should be able to find investment performance data on your investment paperwork. It is helpful to study the track record of each bond holding. You can also utilize Yahoo Finance to look up the quality of your investment on Yahoo Finance. I have found Yahoo Finance to be incredibly accurate. Not to mention that it’s free.

How did your bond holdings hold up in 2002? How about 2008? If there is not enough historical data to support your research, then examine the underlying index that your investment is most often compared to.

Step 2. Research Bond Asset Classes

When you begin researching asset classes, start with the bond allocations. It was during this investigation that I conducted back in 2006 and 2007 that helped me prepare my client’s assets for the upcoming storm in 2008.

Once you learn more about how individual asset classes work—and more about inverse correlations, your eyes will open as to how there is always something making money.

Through your research, as in mine, we can conclude that there are multiple bond asset classes. And while some of them like high-yield bonds have high correlations to the stock market, many, historically, do not.

Attached is an example from an actual model that I was using back in 2006. The red color represents Treasury Notes and the pink color represents Intermediate-Term Government bonds. Note the extremely large allocation in each of these two asset classes.

Source: JH&A Wealth Management Asset Allocation Plan, 2006.

Both of these asset classes returned about +6% each in 2008. Did you catch that? Not one, but two of these bond holdings not only minimized losses but they gained +6%.

To add to this relevance, you probably remember US Large caps down -36%, and Emerging Markets down -52% in 2008. For this conservative client, at least 45% of their portfolio made +6%, or maybe about +5% after my fee, but you get the point.

Was 2008 a terrible year with very few places to run? Yes. But anyone who had performed the research I had at the time probably had the same end result. Of all these asset classes, there may be one, two, or three that hold up respectably during the next downturn.

Step 3. Explore What Other Seasoned Investors are Doing Now

Here’s more good news. If you’ve read this far, you’ve already started step three. Congrats! To help you on your journey, here is a graph that shows one of Vanguard’s current models.

Source: The Vanguard Group, 2018.

Notice how Vanguard places as much emphasis on their bond diversification as they do their stocks. You may even print out this page and research these ticker symbols yourself. Were any of the Vanguard ETFs in positive territory in 2008?

You Are Who You Are Because of What has Went Into Your Mind

Two sentinel books I read before the crash of 2008 were: All About Asset Allocation by Richard C. Ferri CFA, and The Intelligent Asset Allocator by William Bernstein. These books were central to the decisions I made in 2006 and 2007—before the crash of 2008.

These books could be good guideposts for you. You may benefit by understanding how these seasoned investors manage money. Not because they know everything, but because they have invested more thought into it than you and I have. Why not learn from them?

My hope is that you learned something useful by reading this article that can effect positive change. One bit of quantifiable insight that can help you prepare for the next stock market crash. Whenever that may be.

About The Author

Jeff Headrick is a financial planner with Inspire Financial Planning. When Jeff was still in his teens his father died unexpectedly. While his father was a hard worker and a good provider, he did not have the best financial plan in place when he died. This personal experience, coupled with being inspired by Dave Ramsey, Warren Buffett, and the laws of compound interest, prompted Jeff to enter the financial services industry in 1999. He has been helping people ever since.

Jeff lives in Wilmington, NC with his wife and two children. He spends most of his spare time just across the Intracoastal Waterway in Wrightsville Beach, enjoying the beauty of the NC Coast.

If you have a financial concern you’d like to speak to Jeff about, click here to schedule a brief conference call.

Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. The information presented does not constitute financial, legal or tax advice and should be used for informational purposes only. Since individual circumstances vary, you should consult your legal, tax, or financial advisors for specific information.